Time To Sell This Retail Stock Post-Earnings?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For many months I have always stated that I prefer Five Below (NASDAQ: FIVE) over Michael Kors (NYSE: KORS) as an investment. My reason has been simple: Five Below still had significant room to expand and has a long-lasting identify with “everything under $5”, while Michael Kors’ products are dependent on staying “cool.” However, after seeing the quarterly performance of Five Below, I am no longer sure.

A Look At The Quarter

Five Below reported earnings on Wednesday that beat expectations, thus pushing the stock higher by nearly 4%. In the quarter, Five Below posted revenue growth of 33% year-over-year with total sales of $95.6 million. The company also posted an EPS of $0.05 which was $0.01 better than the consensus.

Personally, I bought shares of Five Below in 2012 at $26 even, and I have remained bullish as the company’s comparable store sales have been impressive to compliment a large expansion program. The company already has 258 stores and has plans to expand to 2,000 in the next several years. Thus, Five Below is in a growth phase, unconcerned with margins or efficiency.

So What’s The Problem?

In the past, nothing has worried me regarding Five Below, as I’ve never had any reason for concern. Yet, during this last quarter, I saw two things that caused me to worry: Growth and comps. This is a company that increased its total store count by 6% in the quarter and saw comparable store-sales growth of just 4.2%. To put this in perspective, it is about half of the large company Gap, indicating that Five Below may be losing its appeal to the teenage crowd that led to its growth in the past.

Now, to go a step further in putting its comp growth in perspective, consider the fact that Michael Kors had comparable store sales growth of 36.7% during its last quarter. Yet, Michael Kors is about six times larger than Five Below in the revenue department.

To me, size is important when assessing retail. As a company grows and adds new stores it is going to make mistakes and have unprofitable and lagging stores. In theory, more stores means more revenue, but when those stores are appropriately placed, it can increase margins if comps continue to rise. However, like all businesses, as a company’s revenue grows larger its year-over-year growth will decline; it’s much easier to produce 100% growth when you have $100 million in revenue versus $10 billion in revenue.

Therefore, Five Below’s 33% growth with 4.2% comp growth is a bit worrisome to me. Five Below posted revenue of under $100 million, which is way too small for it to be seeing such decelerated growth. The company is currently trading at 4.5 times sales at 40 times next year’s earnings. Michael Kors trades at 5.5 times sales and 18.5 times next year’s earnings. Yet, Michael Kors produced revenue growth of almost 60% last quarter. This is significantly greater than Five Below -- yet Michael Kors remains a much larger company – meaning I may have had my long-term outlook incorrect.

Conclusion

I, for one, have always compared Michael Kors to Five Below. Perhaps the reason is because both became public companies within a year of the other and share similar valuations. With me, it has always been one or the other as an investment choice – and I chose Five Below.

In my book Taking Charge With Value Investing (McGraw-Hill, 2013) I discuss thoroughly the importance of not allowing your emotions to connect you to an investments. I teach investors how to constantly reassess their positions and to identify when a stock no longer presents value. In my opinion, Five Below is now an example of this scenario, as a smaller company that should be growing rapid with decelerating growth, declining comps, and a rising stock price.

With all things considered, I see now as a good opportunity to sell Five Below and possibly buy Michael Kors.

Michael Kors is one of today's hottest high-end fashion brands, and that's translated into one of the best-performing stocks in retail. But with all that growth, has the stock finally become too expensive, or is there still room left to run? The Motley Fool's premium report on Michael Kors gives investors all the information they need to make the right decision, covering the must-watch areas, opportunities, and threats to the company that investors need to know. To claim your copy, simply click here now for instant access.


Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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